Sept. 21 (Bloomberg) -- IStar Financial Inc., the
commercial real estate lender trying to restructure some of its
$8.6 billion of debt, may seek bankruptcy protection after
creditors blocked it from amending loans, said people with
knowledge of the plan. IStar fell 13 percent.

The company expects to begin meeting with creditors in
coming weeks to discuss potential terms of a so-called pre-packaged bankruptcy, which wouldn’t occur until sometime next
year, said the people, who asked not to be identified because
the plan isn’t public. IStar, led by Chairman and Chief
Executive Officer Jay Sugarman, hasn’t yet held talks with
creditors on a possible bankruptcy. That process is likely to
begin as soon as next month, the people said.

IStar, which has a market capitalization of about $316
million after shares lost more than 90 percent of their value
since 2007, hired Lazard Ltd. and Kirkland & Ellis LLP to advise
on the debt restructuring, the people said. The New York-based
company made loans on properties including the Trump SoHo hotel-condominium building in lower Manhattan.

“IStar grew as the markets shot up and concentrated in
asset classes that are particularly cyclical such as hotels and
construction,” said Ben Thypin, an analyst at Real Capital
Analytics Inc. in New York. “Their fortunes are closely tied to
the market and their future is now uncertain.”

Bankruptcy is one option the company is weighing. It is
also considering a proposal to extend maturities on its debt as
well as a potential exchange offer, according to two people
familiar with the situation.

Silver Point, Monarch

Hedge funds that hold some of iStar’s $2.9 billion of
second-lien loans include Silver Point Capital LP, Davidson
Kempner Capital Management LLC and Monarch Alternative Capital
LP, according to two of the people. Some of the funds, which are
represented by Akin, Gump, Strauss, Hauer & Feld LLP, opposed
iStar’s bid to amend terms of the loans to repurchase debt at a
discount, the people said.

IStar withdrew the proposed revision and has begun the
process of planning for a potential bankruptcy as it is faced
with about $2.6 billion in debt coming due next June, one of the
people said. The company also has an optional $500 million
first-lien debt payment due at the end of September that it may
not make, according to the person.

Foreclosures

In a pre-packaged bankruptcy, a company negotiates terms of
a reorganization with its key stakeholders before filing for
Chapter 11 protection, allowing the proceedings to finish in
weeks or months rather than years.

Representatives of Lazard, Akin Gump and Silver Point
declined to comment. Representatives of Kirkland, Davidson
Kempner and Monarch didn’t return messages for comment.

The company had net debt obligations of $8.6 billion as of
June 30, according to a regulatory filing last month. IStar had
about $3 billion of non-performing loans as of June 30 and
reported an $83.4 million second-quarter loss, excluding income
from property sales.

“Convincing lenders that iStar can repay its obligations
in full at some point down the road appears to be a tough sell
due to uncertainty around the value of its collateral,”
analysts at debt-research firm CreditSights Inc. wrote in a
report last month. “Negative earnings continue to be driven by
the weak credit performance of iStar’s portfolio.”

Credit Rating

IStar foreclosed on nine properties during the second
quarter and said loss reserves totaled $1.18 billion, or about
16 percent of the loan volume it manages.

The company, a real estate investment trust, began in 1993
and was previously called Starwood Financial Trust.

IStar’s debt and equity plunged in the second half of 2007
as commercial-property prices fell and capital markets seized up
as losses on subprime-mortgage securities spread to corporate
bonds. Moody’s Investors Service in September 2008 cut the
company’s credit rating to below investment grade.

While iStar shares have risen more than 36 percent this
year, investors who held the stock from the end of 2007 would
have lost about 85 percent.

IStar fell 53 cents, or 13 percent, to $3.48 as of 4:07
p.m. in New York Stock Exchange composite trading, after
reaching $2.88 earlier today.

The firm’s $501.7 million of 8.625 percent bonds due in
2013 fell 5.6 cents to 78 cents on the dollar, the lowest since
March, according to Trace, the bond-price reporting system of
the Financial Industry Regulatory Authority. IStar’s $448.4
million of 5.95 percent bonds due in 2013 fell 3 cents to 75
cents on the dollar, according to Trace.

“The firm should not become insolvent and has ample
liquidity to operate through 2010, but management faces a
significant challenge with $3 billion in debt coming due in 2011
and $3.5 billion due in 2012,” Standard & Poor’s said July 30.

S&P earlier said it believed there was a “likelihood” the
real estate investment trust would use a so-called distressed
exchange to restructure the debt maturing next year and in 2012.